What’s New

Another Federal Reserve meeting came and went, and policymakers opted to skip a rate hike. With significant focus on when the rate hike cycle will reach its peak, Fed officials signaled that they are likely to hold rates higher for longer through 2024 than originally expected. Rates are currently at a 22-year high.

As markets digested the higher-for-longer narrative and the subsequent move in yields, the major indices, the S&P 500, the Dow Jones Industrial Average, and the NASDAQ all moved lower throughout the month. Although, the S&P 500 is still up 12% on the year due to a group of stocks that rose earlier this year.

In fixed income, the 10-year treasury closed out the month yielding 4.57%. The rise in the 10-year Treasury, coupled with a fall in earnings yield for the S&P, has significantly narrowed the gap between the two.

Beyond the Fed...

Contrary to public discussion, and although we have seen an improvement from its peak, inflation is not under control. Given factors like wage growth and the recent spike in energy prices, the economy could see more inflation spikes. Beyond inflation, there are several other uncertainties facing the US economy:

• The U.S. lost 4.1 million days of work in August to strikes. Strikers are negotiating wage increases and the reinstatement of cost-of-living adjustments, with the United Auto Workers (UAW) being the latest to strike.
• The consumer has remained resilient as of late, but it could be a rocky road ahead. The excess savings from unprecedented fiscal stimulus during the pandemic has now been spent down as consumption levels remained resilient.
• Student loan payments are restarting, and many have already begun the process of servicing their debt. We have started to see cracks, with consumer delinquencies – auto loans and credit card debt – moving higher.
• At the end of the month, a government shutdown was temporarily averted due to the approval of a stopgap plan that will fund the government until mid-November. This shutdown would have come at a delicate time. The US recently saw its debt rating downgraded in large part because of factors previously discussed: government dysfunction, excess consumer savings being run down, delinquencies starting to tick up, and student loan payments kicking in as energy prices rise further. None of this bodes well for risky assets.

Our Perspective

As inflation, the Fed, and interest rates remain a key narrative for the economy, we have been adamant that a soft landing outcome is unlikely. Historical evidence suggests that the Fed has never brought inflation down (from the levels we’ve seen) without causing significant economic hardship. Should the Fed begin cutting rates next year, we believe it is more likely than not that it will be in response to an adverse economic outcome, and therefore, we anticipate the Fed would have to cut fairly aggressively. Stated simply, the Federal Fund’s rate often takes the stairs up, but the elevator down.

Given this, the market is likely going to have to reprice its outlook with higher yields, rising uncertainties, and, we believe, weaker earnings. The market is forward looking, and typically looks beyond a recession until it has hit. As a result, there are rapid price moves and the adverse outcome occurs, which is the risk we are working to manage.

With that in mind, we are placing an emphasis on risk management and have adopted a defensive position strategy in our core portfolios. As active managers, we are building our portfolio to be able to weather nearing market volatility, while adding to our watchlist. In terms of pro-cyclical sectors, we are crafting our shopping lists and watching for opportunities to increase our exposure in those areas of the market.

Break’s Over: Student Loans’ Influence on the Economy

Millions of Americans have been living in a period of forbearance for student loan repayment. During this time, less than 1% of borrowers continued making payments. With payments resuming in October, how will this impact borrowers, consumers, and the overall health of the economy?

Read our views here: Break’s Over: Student Loans’ Influence on the Economy

Our View
Economic Cycle		The economy is late cycle. The Fed has hiked aggressively and while the economy has remained resilient to date, the manufacturing industry is showing serious pain and we anticipate that the lagged effect of monetary policy will start to be felt in other parts of the economy in the coming quarters.
Stock Market		The US stock market has rebounded strongly off its October 2022 lows. Sentiment now appears stretched and valuations are not compelling. To date, market returns have been driven by multiple expansions. EBIT margins climbed to historical highs in the years following COVID lockdowns; elevated input costs and weakening demand and pricing power are posing a risk to the ability of corporations to maintain earnings at their projected level. Returns will be harder to come by and stock selection will be increasingly important.
Bond Market		Interest rates remain well off of their lows, as the economy has remained resilient and the market weighing the dynamics of still-elevated core inflation and the potential for interest rates to remain higher for longer. Corporate spreads remain well contained, particularly in light of the risks we see to the economy.
Important Issues on the Radar		Inflation: Factors including a resilient demand environment and wage increases threaten to keep core inflation elevated. Should this be the case, the Fed may remain tighter for longer.
		China’s Economy: China has pivoted on the two key economic issues that acted as severe headwinds to growth over the last two years; however, economic growth appears to be stagnating and it will be critical to monitor the policy response in the coming months.

Indicates change Indicates no change

Source: Wall Street Journal, Bloomberg, National Student Loan Data System

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